Justin Trudeau’s marijuana czar is warning that policy makers may need to adjust taxes to prevent prices from falling too low after legalization.

Canadian marijuana companies — which have surged in value — will achieve economies of scale that will help drive down production cost, according to Bill Blair, the lawmaker and former Toronto police chief leading the legalization effort.

Prices and taxation levels will then need to be monitored to keep them competitive enough to achieve the government’s goal of starving out the illegal market, without pricing things too low and encouraging excess use, Blair said in an interview last month.

“You’ve got to pay a lot of attention to what’s going on in the illicit markets,” he said. Legal pot needs to be “competitive in not just price but in quality and choice and accessibility.”

Marijuana firms including Canopy Growth Corp., Aurora Cannabis Inc., Aphria Inc. and MedReleaf Corp. surged last week to close out 2017. Canopy ended the year with the best returns on the S&P/TSX Composite Index, data compiled by Bloomberg show, and the BI Canada Cannabis Competitive Peers Index reached a new high last week. Some analysts are skeptical about demand projections, and betting against the stocks is difficult to do.

Falling Prices

Canada plans to legalize recreational pot use by the summer, though the law to do so is wallowing in the Senate. Leisure use began in California this week, and Blair said other jurisdictions have seen prices fall as their markets develop.

“I think there are, almost inevitably, economies of scale that will be realized both in production and in the distribution,” Blair said. “Over time, prices do come down.”

In a follow-up written statement, Blair said the price of pot will be determined both by the market and by provincial regulators. “The provinces may use both price and tax levers to maintain a price that is both competitive with the illicit market and not so low as to create an incentive for increased use,” he said.

The Canadian government projects an annual market of about $4 billion (US$3.2 billion) for legalized marijuana. The country’s finance ministers have agreed on a marijuana excise tax of 10 per cent of the product price, or $1 per gram, whichever is higher. Sales taxes, ranging from 5 per cent to 15 per cent across provinces, will also be applied. The federal government has agreed to hand over at least 75 per cent of excise tax revenue to provinces for the first two years after legalization.

Nick Dean, chief executive officer of licensed medical producer Emblem Corp., said he expects the marijuana industry will be able to compete with the black market.

“The strategy right now is we would be selling at a competitive price and that’s been supported by the government,” he said in a phone interview. “The best way to displace the black market is through education and brand, and people are willing to pay a premium for a brand experience.”